Canada's technology star becomes financial black hole

It has come to this for Nortel Networks Corp.

The federal government cleared the way on Sept. 16, 2009, for Swedish telecommunications giant Ericsson's $1.13-billion-US takeover of two key wireless divisions of Toronto-based Nortel.

Industry Minister Tony Clement said that under the transaction, Nortel will retain rights to technology that opponents of the sale had argued are important national assets.

Ericsson said the deal for Nortel — which was once the cornerstone of Canada's technology industry, with a market valuation of nearly $300 billion — will close next month.

As Canada's technology giant, Nortel once boasted a market capitalization about half the size of Mexico's entire gross national income and a workforce equal to the population of Waterloo, Ont.

But as the telecommunications equipment maker slid into bankruptcy in January, Nortel's net worth was said to be a shade under $200 million.

"Great technology company, very bright technology-driven people — made a lot of bad acquisitions during the bubble that ended up diluting the stock massively," said Mark Goldberg, a Toronto-based telecommunications expert.

In January 2009, Nortel sidestepped $107 million in upcoming interest payments and sought court protection while the firm puzzled over its next steps.

That plan entailed the piecemeal selloff of its divisions, including:

• The enterprise unit. which fetched $900 million US from Avaya.
• The CDMA business, which Ericsson wanted. CDMA stands for code division multiple access, a wireless-channel access method.

At the time of the bankruptcy petition, however, Nortel did have more than $2.6 billion in cash, making a court protection filing a puzzle for some analysts, especially considering that buyers usually shun equipment providers in financial difficulty.

"Roughly $100M regular interest payment is due. Company has roughly $2.6B cash. Hard to see this payment as a catalyst for bankruptcy but many stranger things have happened," said one stock analyst in a January email prior to Nortel's move.

For other telco watchers, such as DSAM's Duncan Stewart, however, Nortel was already on the path to financial "ground zero" and figured to save the money by going into protection sooner rather later.

Whatever the reason, the filing represented an inglorious end to Nortel chief executive officer Mike Zafirovski's four-year attempt to turn the company around. He arrived at Nortel in 2005 as a highly-touted chief operating officer from Motorola Inc.

"We are very happy to see 'Mike Z' take over. He is very well regarded as a very strong operational manager. We believe he has the perspective needed to focus Nortel's strategy. More importantly, he has the guts/drive/stamina to clean house and actually implement it," wrote CIBC World Markets Analyst Steve Kamman in a bulletin in 2005. 

Zafirovksi certainly took a broom to Nortel, cutting more than 4,000 jobs.

But, in 2008, Nortel — similar to many communications equipment providers — ran into the buzz saw of increased competition from the likes of China's Huawei Technologies Co. Ltd. and lessened customer demand for expensive gear, such as the Canadian company's optical Ethernet switches.

This trend will continue, industry observers said.

"In 2009, executives face challenging global economic conditions that have not existed for more than 50 years," said Mark McDonald, group vice-president and head of research for Gartner EXP, a U.S. technology think-tank.

As a result, Nortel's September sales and revenue warning, which cut the share price by 45 per cent, was a likely portent of future financial difficulties.

Long pedigree

Nortel began its corporate life in 1895 making equipment for traditional phone companies in Canada, a few years after Alexander Graham Bell invented the telephone.

Originally, part of Bell Telephone, it morphed into Northern Telecom, and finally Nortel. The company remade itself as an Internet company in the 1990s and was often called the poster boy for companies making the transition into the new economy.

For many years, Nortel was known as the company that made your phone, a nice business but hardly something to get excited about.

By 1997, major changes began at Nortel when John Roth took office as the company's president and chief executive officer. He correctly saw that the marketplace of communications was shifting from telephone technology to the Internet.

The trick was figuring out how to speed up the process of getting new products and services into the market so Nortel could keep ahead of the fast-paced web world. In the past, it often took as long as five years to complete a research and development project.

Under Roth's leadership, Nortel was dramatically restructured, outsourcing production and shuttering 18 of the company's 24 plants.

The changes helped put Nortel at the top of its league. By some estimates, Nortel equipment was carrying 75 per cent of the Internet traffic in North America as the 1990s came to a close.

Nortel went on frequent buying sprees, often using its own stock to take over tiny companies with promising technologies. In 2000 alone, it bought 11 companies for a total of $19.7 billion US.

Pop!

And then the bubble burst.

One bad bet Nortel made was in the area of wireless equipment where Nortel produced gear according to a standard known by the acronym 'CDMA', or code division multiple access.

Analysts said the equipment was top-notch but not popular because many providers decided to follow the European wireless communication standard GSM.

"It is like going with Beta over VHS: Beta delivered a better picture and hi-fi sound, but consumers voted for VHS. In many ways, the mistake on wireless demonstrates that the company may have been a victim of focusing on technology ahead of understanding the market," Goldberg said.

In addition, service providers — landline, wireless and internet — were overly optimistic about customer growth. That led them to slow their purchases of telco equipment.

Nortel's best customers — telephone and data carriers — began warning that they would be drastically cutting back on their purchases of specialized Nortel equipment. Nortel's sales plunged by 50 per cent. The value of the companies Nortel had bought collapsed too. In less than a year, firms that Nortel had paid billions for were worth just hundreds of millions.

Following the dramatic downward revision in the company's outlook for 2001, some industry watchers began questioning Roth's leadership and credibility, especially since the company earlier promised three times that it would meet its 2001 financial targets. Irate investors filed numerous lawsuits against the firm.

Roth, named Canada's "business leader of the year" in 2000, stepped down as president and CEO in early October 2001, replaced by Frank Dunn. The company announced another 10,000 job cuts and a third-quarter loss of $3.47 billion later that month.

The wheels come off

The jobs cuts continued as Nortel struggled to deal with the unprecedented downturn in its business. By the end of 2001, Nortel had just 45,000 employees — half the workforce with which it had begun the year.

The bottom line for 2001 was brutal — a loss of $27.3 billion US.

And 2002 brought more misery, and mere glimmers of hope.

In February, the company's chief financial officer, Terry Hungle, resigned following allegations that he broke the company's trading rules in some of his personal stock transactions.

In subsequent months, Nortel warned that business was still not picking up; its long-term debt was downgraded to "junk" status by both Moody's Investors Services and Standard & Poor's; and by October, its shares had plunged to just 69 cents — more than 99 per cent lower than where it had been barely two years earlier.

More job cuts brought the company's work force to 35,000 by the end of 2002, about one-third of the work force Nortel had at the start of 2001.

Then, two years of savage job-cutting started to pay off. The company managed a $54-million US profit in the first quarter — its first quarterly profit in three years.

Its stock price began to rally, topping $6 by September as it signed billions of dollars in new deals with Verizon Wireless in the U.S. and Orange in France.

Technology companies were again spending — not like they were in 1999 — but at least they were spending.

Nortel announced new deals with mobile phone companies Verizon and Orange. In October 2003, the company posted another quarterly profit and in January 2004 it announced its first annual profit since 1997.

The profit that wasn't

But in March 2004, Nortel warned that it would delay filing its audited financial statements for 2003 and would likely make more financial restatements, sending the stock plunging. The company then put its chief financial officer and controller on paid leave. The stock sank again.

Both the U.S. Securities and Exchange Commission and the Ontario Securities Commission began investigations in April 2004 of Nortel's earnings restatements.

Then on April 28, 2004, Nortel fired its top executive, Frank Dunn, and the two executives who had been on paid leave, and put four more on paid leave. It said a preliminary review suggested its calculated profit for 2003 would have to be reduced by 50 per cent.

In May 2004, the U.S. Attorney's Office in Dallas launched a criminal probe into Nortel, requesting documents going back to Jan. 1, 2000. The Ontario Public Service Employees Union Pension Trust filed a class-action lawsuit against Nortel a few days later.

Nortel's problems continued when it said on June 2, 2004, that its updated financial results for 2003 and the first quarter of 2004 still weren't ready. It subsequently missed three self-imposed reporting deadlines as it struggled to unravel the accounting mess left by the previous management.

Another criminal investigation into Nortel's accounting practices, this time by the RCMP, began in August 2004. Days later, Nortel cut 3,500 jobs, about 10 per cent of its workforce, and fired seven more people from its finance department over accounting problems. Nortel later announced the job cuts would total 3,250, with 950 of those jobs coming from Canada.

When Nortel finally filed its 2003 financials in January 2005, the revisions lowered the company's initially-stated profit of $732 million US to $434 million US. Its 2004 financials, reported in May 2005, showed that the company actually lost money that year — $51 million US. Revenues fell 3.6 per cent from 2003. CEO Bill Owens said he wasn't happy with the results, but said that Nortel, at last, was "now stable."

Just a month later, the company's president and chief operating officer, Gary Daichendt, and its chief technology officer, Gary Kunis, resigned. Both had been with the company less than three months.

In October 2005, Nortel picked Zafirovski to succeed Owens as CEO. Several months later, Nortel announced it had put aside $2.5 billion US to settle the class-action lawsuits stemming from the company's 2004 accounting scandal.

In March 2006, Nortel again announced its financial filings would be delayed and it would restate financial results for 2003, 2004 and the first nine months of 2005. It also announced a $2.2-billion US loss for the last quarter of 2005, due mainly to the cost of litigation to settle lawsuits from its shareholders.

Within months, Zafirovski announced a further restructuring. The changes included the elimination of another 1,100 jobs, the conversion of the company's pension plan to one that doesn't guarantee a specific pension benefit, and a trimming of other retirement benefits.

But Nortel's rebuilding efforts were not over yet.

Despite shedding more than 60,000 jobs in six years, the company announced another 2,900 job cuts in February 2007, a move that would bring the payroll down to 31,000.

Another 1,000 jobs would switch to lower-cost countries like China, India and Mexico.

But while Nortel was still North America's largest maker of telephone equipment, it was making news for the wrong reasons.

Criminal charges

In March 2007, the U.S. Securities and Exchange Commission and the Ontario Securities Commission announced legal proceedings against Dunn and three other former senior executives.

The SEC accused the four of civil fraud relating to Nortel's accounting and its restatements. The OSC alleged that Dunn and two others broke securities laws by making "material misstatements" in Nortel's financial filings that they knew or should have known were "materially misleading."

In June 2008, the RCMP charged Dunn and two former executives with fraud.